Thursday, May 19, 2011

More on Company Towns, Legal History, and Economics

Posted by
David Bernstein

An anonymous commenter writes:

The company towns example raises a concern I have about an economic approach being applied too readily. The difficulty with economic analysis as it is often (not always) applied is that it omits the non-financial issues which clearly were important to people - it's like people who rely on Adam Smith but have read the Wealth of Nations, but never the Theory of Moral Sentiments. One needs to read both to understand Adam Smith's ideas fully.

Taking a British example, a number of nineteenth century industrialists set out to provide effective company towns for their workers. However, others did not. One distinction was that the owners of companies who created company towns were often methodist or otherwise "evangelical" low-churchmen and thought they had a moral (not financial) obligation to their workers.

Good economic analysis can incorporate such ideas as and motivations within it, but often the only way one realises that one needs to incorporate the ideas is by doing good history in the first place - starting from the economic perspective alone won't do it.

I agree with the overarching sentiment, but I'm not sure that what the commenter is suggesting is actually at odds with an "economic perspective."

Surely, there is a crude economic perspective that suggests that individuals are motivated by financial self-interest, or, from the Marxian perspective, class interest. But I don't think that this perspective has many adherents in neoclassical circles (I can't say that I'm up on the latest in Marxist theory).

The real economic puzzle here is "why have a company town"? A pat answer: because this allowed the "company" to exploit the workers, who had no bargaining power. Economically-oriented response: "Wait, that doesn't make sense, if the company was simply exploiting the workers, it could just pay them less." So "why have a company town?" If one answer is, "because some rich Methodists who were not accountable to shareholders thought it was their duty to 'uplift' their workers, even at the expense of greater profits," that is a perfectly reasonable ECONOMIC motivation, if we understand economics, as Ludwig von Mises famously suggested, to be the "science of human action."

"Economics," as I understand it, takes people's preexisting goals--be they venal, charitable, religious, racist, or whatever--as a given, and then assumes that people will try to achieve those goals in the least "costly" (in financial and other costs) manner. If a businessperson is acting through purely venal motives, trying to exploit his workers, one would expect that he will simply pay them less, rather than set up a Rube Goldbergesque scheme of local monopoly that will be less effective in achieving his exploitative goal. On the other hand, if a businessperson feels a paternalistic obligation to his workers, one method he may try is to establish a company town that will both provide basic social services to his workers, and also enforce moral norms that will make it more difficult for his employees to fall victim to drink, gambling, or other vices.

I'm at fault for not making this clear. I wrote, "economics teaches us that companies aren’t likely to do something that’s contrary to self-interest." I should have written something more like that "economics teaches us that companies seeking to maximize profit aren't likely to engage in widespread behavior that seems obviously contrary to that goal"--like trying to "exploit" powerless workers by setting up a company town, rather than simply reducing their wages. In my previous post, I provided a few plausible explanations as to why profit-seeking enterprises might nevertheless set up company towns. The "Methodist" example is another possible explanation--that maximizing profits was subordinate in some cases to other goals--and yet another possibility is that company towns were a risky and often temporary venture, and no one else may have been willing to invest the needed capital in housing and the like.

All of these are plausible answers to the company town mystery, and none are necessarily exclusive of the others; different explanations, or a combination of explanations, may explain any given town. Economics provides the tool to question the simplistic "exploitation" argument, and perhaps provide hypotheses to explore, but it takes good historical work to figure out what was actually going on. And that's why I think economics and history are allies, not enemies.

You write, ""Economics," as I understand it, takes people's preexisting goals--be they venal, charitable, religious, racist, or whatever--as a given, and then assumes that people will try to achieve those goals in the least "costly" (in financial and other costs) manner."

The problem is, that's not how economics as a field actually works. What percentage of economics papers invoke a utility function that cares about much beyond money? How often are normative conclusions drawn about the efficiency of a particular arrangement based on purely self-interested utility functions? Indeed, a large swath of the field militantly opposes expanding the utility function as ad hocery run amock, and want to push the (narrow) rational model as far it can go.

Economist and blogger John Quiggin had a brilliant summary of the move you just invoked in a post on economic imperialism:"First, most rational actor models assume that “rationality” can be represented as “maximization of self-interest”. This assumption is either false or vacuous. Those committed to egoistic rationality tend, when challenged, to oscillate between the two definitions, in much the manner of the function sin (1/x) as x approaches zero."

While rational choice approaches can, in principle, function as you suggested - by examining what people's preferences actually are and taking them as given - it rarely does so, and usually only invokes this abstract (and vacuous) characterization of rationality when challenged for being too narrow.

I'm perhaps unqualified to debate Quiggin on this, but "maximization of self-interest" SHOULD mean, and good economists, in my view, understand it means, maximization of self-interest not in some "objective" or "rational" sense of self-interest, but maximization of the subjective preferences of the individual in question. Thus, a person who gives away all of his possessions to become a monk is maximizing his self-interest, because he's decided that he wants to become an impecunious monk.

Any economist who would deny that some people try to maximize, e.g., political power, ideologically favored outcomes, religious obligations as understood by an individual, happiness and self-actualization, etc., as opposed to pecuniary wealth, isn't worth paying attention to. At least at George Mason, I doubt any of my l & e colleagues, including the Ph.D. economists, would disagree.

There may be cases, e.g., studying the behavior of hedge fund managers, where using wealth maximization for modeling purposes can be justified, but these examples are limited, and should be seen only as simplifications that are "good enough" for limited purposes, and not as some sort of scientific approach to human behavior.

But I'm not a big fan of mathematical economic modeling of the sort that is so common in economics today; I am a big fan of economic reasoning of the sort I described. So let's posit that I'm in favor of economic reasoning, but not necessarily economic "methodology."

To spell out the point a bit further, in the absence of an objectively observable measure of self-interest, there is no difference between "People maximize their self-interest, whatever that is" and "People do what they do, whatever that is".

I don't suppose many of your colleagues would disagree with this. As the previous commenter observed, it's vacuously true. There's no reasoning involved.

Thanks to the last commenter for joining in. Just a note to readers: from his Blogger profile, it doesn't look as if this John Quiggin is the same as the one referred to by Dan aka asociologist. That Quiggin blogs at Crooked Timber. Please correct me if I'm mistaken,

Quiggin: To spell out the point a bit further, in the absence of an objectively observable measure of self-interest, there is no difference between "People maximize their self-interest, whatever that is" and "People do what they do, whatever that is".

No, I think that's wrong. There's a huge difference between "people try to achieve their goals, whatever they are," and "People do what they do, whatever that is." The former still requires purposeful action. The latter would mean that we could equally expect an individual who wishes to drive from Chicago to New York to rent a car or to wave a chicken around his head.

Suppose that you observe an individual saying "I want to drive from Chicago to New York" and swinging a chicken around his head. Given a methodological commitment to rationality assumptions we can infer either that the individual truly wishes to drive to NY and has some mistaken beliefs about how to do it, or that they enjoying lying and chicken-swinging. Unless you have some objective basis for knowledge about their preferences, the equivalence I stated is tautological.

Economics as a discipline isn't very helpful unless one's defines rationality in a fairly narrow way and postulates goals of a primarily materialist nature. E.g., a suicide bomber may in some sense be acting rationally in his pursuit of Islamic paradise, but nothing studied in Econ 101--or even Econ 310--will be very useful in analyzing or predicting his behavior.

Fortunately, most people spend most of their time pursuing fairly material, and universally shared, goals, i.e., money, leisure, financial security, etc. Therefore, the discipline of economics is very useful in analyzing and predicting the behavior of large numbers of people for large portions of the time.